The Hayek Effect: The Political Consequences of Planned Austerity

Why the political revolt in Greece may not be a fluke, but a harbinger of more revolts to come.

In 2010, Merriam-Webster’s Dictionary named “austerity” as its “Word of the Year,” noting that it had been the subject of more than 250,000 searches on its free website. This sudden flare-up of interest in austerity did not arise because large numbers of people suddenly decided to live like Trappist monks. Rather, it was owing to the austerity programs that the creditor nations of the European Union, led by Germany, had decided to impose on the EU debtor nations, such as Greece, Ireland, Portugal, and Spain. In return for a pledge to continue loaning the debtor nations more money, the creditor nations demanded that the debtors must in effect tighten their belts. This belt-tightening required slashing some of the government-provided benefits and social services that the citizens of the debtor nations have come to take for granted. It also took the form of higher taxes and lower wages.

These EU austerity programs did not lack critics among economists, many of whom had long decried the austerity programs that the IMF had been imposing on underdeveloped nations that proved unable to repay their debts. The argument of the critics went like this: Austerity programs not only caused distress and suffering to the general population of a country—most of whom had received no benefit from the original loans—they were also counter-productive from an economic perspective. Austerity programs would tend to degenerate into a vicious cycle. Cuts in government spending would lead to an economic down-turn, even a severe recession, naturally accompanied by higher unemployment. This, in turn, would reduce government revenue, requiring further bailouts from creditors, who would demand further austerity measures, and so on.

Because all EU nations are democracies, this meant that the voters could easily reject the highly unpopular austerity programs by the most obvious method available to them.

The fate of the European austerity program, however, has not been left up to the economists, either those who supported it or those who opposed it. Instead, it has become a hot political question, and for good reason. The fact that the governments of debtor nations all adopted the EU-imposed austerity programs did not make them any more palatable to the citizens who had to live under them. Because all EU nations are democracies, this meant that the voters could easily reject the highly unpopular austerity programs by the most obvious method available to them. They could vote out of office the party (or coalition) that had agreed to the austerity measures in the first place.

This is precisely what happened in the last Greek election, where the two parties that supported austerity were soundly trounced by the anti-austerity forces. The result has been a deepening political crisis, culminating in the recent failure to form a working coalition government. Under the Greek constitution, new elections will be held in June, at which time, if the polls can be trusted, the anti-austerity forces led by the young and charismatic Alexis Tsipras will take the helm of government, assuming that there is still a government left to take the helm of.

Most of the anxiety raised by the crisis in Greece has focused on the impact of a Greek default on the European and global economy. This is certainly a disturbing question, but I am not convinced that it is the most disturbing aspect of the political debacle in Greece. For what has happened in Greece reveals that there is a grave and potentially catastrophic flaw in the so-called European social model of government, which, according to the historian Tony Judt, “binds Europe together.” In short, what has long bound Europe together may soon tear it apart.

The problem is this: The European model works fine so long as the economy is doing just dandy. But it is not designed to cope with serious economic crises. Under the European model, an economic crisis is virtually guaranteed to become a political crisis—and the situation in Greece today demonstrates just how grave such a crisis can become.

The European austerity programs are the deliberate policy of the governments that have imposed them, and this is a fact that every citizen forced to tighten his belt is perfectly aware of.

The American model, in contrast, does not have this liability. During periods of economic recession, Americans will naturally grumble and many will blame the president or the party that happens to be in power during the downturn. They may even vote a president out of office. But that is pretty much the extent of the political damage. Not so under the European model, where austerity programs have led to mass riots, street violence, and government paralysis, as in Greece. There is a reason for this difference that has little to do with hot Latin blood: It is the unavoidable consequence of the European model.

Free markets “impose” austerity in the form of unplanned economic slowdowns and recessions. At such times, people may ask for the government to intervene in order to stimulate the economy, and they may get angry when it fails to do this, or when it does it unsuccessfully, as in the case of the Obama stimulus package. But no one seriously argues that the period of austerity (i.e., recession) was the deliberate policy of this or that administration. But the European austerity programs are the deliberate policy of the governments that have imposed them, and this is a fact that every citizen forced to tighten his belt is perfectly aware of.

This is the fatal flaw in the European model. There is a tremendous difference between austerity imposed by anonymous market forces, which cannot be politically challenged, and austerity imposed by political institutions, which can be. This fact was pointed out by Friedrich Hayek in his classic book, The Road to Serfdom. In a free market system, everyone can complain when the price of bread (or gas) mysteriously goes up, but so long as the market is determining the price that is all anyone can really do—bitch about it. This is not the case, however, when the commissar of bread announces a new price increase in the cost of a loaf. Then, disgruntled consumers can march to the commissar’s house to express their outrage and indignation. To Hayek, this was a serious political weakness that a socialist or communist state could only deal with by the brutal suppression of those protesting the economic policies of the central committee.

What has long bound Europe together may soon tear it apart.

By pure coincidence, I happened to read The Road to Serfdom during the period of growing unrest in the Soviet Union. People were unhappy about the lagging Soviet economy and they knew just who to blame. They didn’t grumble and complain. Instead, they took to the streets and held mass demonstrations against the government. Because of the liberalization of Soviet domestic policy, mass suppression of the movement was no longer an option. As I watched the Soviet Union crumble, I realized that I was seeing the Hayek Effect—that when centralized planners control the economy, they will naturally be blamed for their mistakes. But I also realized that the Hayek Effect can swing into action even when the centralized planners are not making mistakes. Indeed, the Hayek Effect can create political havoc when the centralized planners are making the best possible decisions under the circumstances. After all, the mere fact that people do not like the economic decisions being made does not necessarily make those decisions wrong. Sometimes the price of bread really does have to go up, in which case it is simply sensible socialist planning to make the upward adjustment.

Needless to say, Hayek did not believe that socialist planning led to rational economic decisions. But suppose for a moment (only a moment) that the socialist planners got it right for once, and that they had imposed austerity because this was the only way they could avoid economic catastrophe. The decision, in this case, is justified, but that makes no difference to those who will be forced to go hungry under the socialist state’s new austerity drive. They will still be angry and they will still know exactly who to blame. In short, even if a socialist government is making all the right economic decisions, it may still land in serious political trouble if the bulk of the people are vehemently opposed to those policies.

How serious this trouble may be was revealed by the collapse of the Soviet Union. Even the handful of people who did not think the Soviet Union would last could never have imagined the speed and violence with which it would be tossed into the trash bin of history. Instead of being stunned into reflection by the magnitude of the shock, everyone began to think that it was the most natural thing in the world for the USSR to have fallen into a million pieces. The people, it was averred, had made a choice for free markets and liberal democracy. What could be more sensible?

The Hayek Effect can create political havoc even when the centralized planners are making the best possible decisions under the circumstances.

My reading of Hayek, however, convinced me that this was a misleading, naive misinterpretation of the Soviet collapse. The lesson I drew applied not only to Soviet Communism, but to any form of centralized economic planning, including the kind favored under the European model. The problem with centralized planning is not that it makes bad decisions. The problem is that, even if it makes good decisions, these decisions will be made by a group of centralized planners and not by anonymous market forces. When these decisions demand austerity, loss of wages, higher prices, and cuts in social benefits, the people will resist them. And if the people get angry enough, they can bring down the government that has tried to impose an austerity regime on them, leading to both increased economic distress and political instability.

Even if the European austerity programs are right on the economics, they are politically disastrous. An oppressive totalitarian regime might try to impose them on its people against their will, through terror and intimidation, but no democracy can hope to do this. The political revolt in Greece, therefore, is not a fluke, but a harbinger of more revolts to come, along with more economic crises and more political paralysis. It would be absurd to compare the EU with the USSR in terms of their relative respect for freedom and democracy, but it is precisely the EU’s tradition of democratic principles that may well doom it to the same fate that befell the Soviet Union—a sudden and shocking collapse, followed by years of economic decline and political turmoil.